Howard Flight was MP for Arundel and South Downs between 1997 and 2005, is a former Shadow Chief Secretary to the Treasury and Deputy Chairman of the Conservative Party, and is now chairman of Flight & Partners Recovery Fund. After being awarded a peerage last week, he will shortly take his seat in the House of Lords.
The point which Lady Thatcher and those opposed to the €uro made nearly 20 years ago, that economies with materially economic characteristics cannot share the same currency for long without trouble, is now clear for all to see.
Ireland experienced a massive bubble in property values because its inflation rate was high compared with that of Germany, where sharing a common currency and common interest rates meant negative, real interest rates in Ireland: so people borrowed more and more to invest in property assets; and with a common currency and no Irish Central Bank, there was no ability to control the expansion of credit. Italy has had little or no economic growth for a decade, as it has become increasingly uncompetitive in manufacturing compared with Germany. Spain and Portugal have also become uncompetitive compared with Germany and also experienced property bubbles and busts like Ireland.
The EU loan facilities put together for Greece and Ireland may sustain the edifice for a while, but the key question is who is going to buy Irish, Portuguese, Spanish, Greek or Italian Government Bonds, when Chancellor Merkel has warned they can expect “a hair cut” on what they are repaid. I do not see how large enough EU/IMF facilities can be resourced to finance the government defects of Spain, Portugal, Ireland and Greece as well as possibly Italy’s deficit?
In this situation the only path to keep the €uro edifice afloat would be for the EU to change the powers of the ECB to enable it to buy such Government Bonds issued to finance their deficits, as required – in other words, QE/printing money, on a massive scale.
The big unanswered political question is as to what were Germany’s objectives behind Chancellor Merkel’s “haircut” comments? The present position of Germany in relation to less competitive Europe is analogous to that of China to the rest of the world. Germany now has, effectively, an undervalued currency and can out-compete everybody else in the €uro block; and is, therefore, booming. Yet Germany, somewhat like China, does not appear to understand the other side of the coin; that they have little choice other than either to buy the Bonds which their less competitive €uro member Governments need to issue to keep their economies afloat, or to help finance them as the major part of EU initiatives.
If Germany’s objective is to hasten EU political and fiscal integration, this, too, is unlikely to be an economic solution under the €uro, as the size of the “transfer payments” required to Southern Europe and Ireland, (which substantially Germany would need to finance) is likely to be wholly unacceptable to German citizens. Even the much more homogenous USA economy has national fiscal “transfer payments” of 34%.
Germany’s strictures about grinding down the uncompetitive economies of Southern Europe are analogous to those of China towards the USA. But where the economies of Southern Europe, and particularly Spain, as well as Ireland, have already very high unemployment, it makes little sense to worsen this. The only solution is for their economies to grow, but this is what they cannot do while sharing a currency with Germany – which is now cheap for Germany but too expensive for them.
The solution is obvious: Germany and other competitive Northern European economies should adopt a new, strong, DM, leaving the €uro as a weak currency for the less competitive parts of Europe. But for Germany, preserving the €uro is seen as essential to the “EU project”. It may be that, in due course as the costs to Germany mount, and their banks lose money on other European Government Bonds, German public opinion will change sharply. But, in the meantime, the necessary economic solution is gridlocked and the problems can only get worse in waves. There is the danger of political instability, as the weaker economies are increasingly ground down, both by the terms of EU/IMF loan bailouts and the fundamental problem of being uncompetitive within the shared €uro currency.
The less the UK is involved in this the better, but we cannot escape entirely because of the exposure of our banks to the banks of those economies being undermined by €uro membership – particularly Ireland. As this currency “theatre tragedy” plays out, clearly, the question is as to what will “blow” next?